Monetary and Financial Policy in the Euro Area

193 Pages·2018·6.17 MB·English

by  Maximilian Fandl

Springer Texts in Business and Economics
Maximilian Fandl
Monetary
and Financial
Policy in
the Euro Area
An Introduction
Springer Texts in Business and Economics
Moreinformationaboutthisseriesathttp://www.springer.com/series/10099
Maximilian Fandl
Monetary and Financial
Policy in the Euro Area
An Introduction
MaximilianFandl
FrankfurtamMain,Germany
ISSN2192-4333 ISSN2192-4341 (electronic)
SpringerTextsinBusinessandEconomics
ISBN978-3-319-72642-7 ISBN978-3-319-72643-4 (eBook)
https://doi.org/10.1007/978-3-319-72643-4
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Preface
About10yearsago,cracksstartedtoappearinthemonetaryandfinancialsystem.In
the fall of 2008, the global financial crisis brought the system to the verge of
collapse. Citizens and policymakers alike were taken by surprise how this could
havehappened.Sufficientsafeguardswerethoughttobeinplace:Centralbanksthat
would provide emergency liquidity when needed, supervisors that would prevent
banksfromtakingexcessiverisksandadepositguaranteesystemthatwouldprotect
depositors from losses. In the fall of 2008, the confidence in the stability of the
systemwasshatteredbyanunprecedentedcrisisonlyfewpeoplehadseencoming.
Crisis management dominated monetary andfinancialpolicy intheeuroarea in
the years that followed. Unlike the Great Depression of the 1930s, central banks
reactedwith abold monetary policy response, significantlyincreasing theliquidity
provisiontothebankingsystemthroughconventionalandunconventionalmeasures.
Governments provided unprecedented fiscal support to the banking sector in the
formofpublicbailoutsandothermeasures.Manyobserverssharetheviewthatthe
monetaryandfiscalpolicyresponsepreventedthefinancialsystemfromcollapsing.
Nonetheless, the European financial crisis deepened in the years thereafter and
morphedintoasovereigndebtcrisisinseveralcountries,followedbypublicbailouts
andlengthyeconomicadjustments.
Asofthetimeofwriting,theeuroarearemainsinanenvironmentoflowgrowth,
low inflation, high unemployment and crisislegacies. Euro area member states are
alsoconfrontedwithnewpolicychallengesandadverseglobaldevelopments,such
asincreasedgeopoliticaltensionsortheslowdowninsomeemergingmarkets.Inthe
fieldofmonetaryandfinancialpolicy,thelast10yearshavebeencharacterizedbya
myriad of changes. Yet, the question remains whether current policies provide us
withadequatecomforttoovercomeboththecurrentandthestructuralchallengesin
theeuroarea.
Aproperunderstandingofthemonetaryandfinancialsystemisessentialtoform
aneducatedopinionaboutsomechallengeswefaceintheeuroarea.Manyobservers
acknowledge the central role the monetary and financial system plays for an
advancedeconomysuchastheeuroarea.Nonetheless,thesubjectisstillnotcovered
adequately in many economics curricula atuniversities. In addition, the number of
policy-oriented books that provide a useful overview of the ‘nuts and bolts’ of the
systemstandsinstarkcontrasttotheirrelevanceforthebroadereconomy.
v
vi Preface
Thisbookprovidesanintroductiontomonetarypolicy,bankingsupervisionand
financialstabilityintheeuroareafromapolicyperspective.Inlinewiththispurpose,
ithasafocuson:
1. Real-worldobservationsinsteadoftheoriesorformulas.Thereasonistoseparate
the process of making observations from proposing solutions to perceived
problems. While the latter is obviously important, it is not the focus of this
book.Atthesametime,thebookmayfacilitatetheprocessbypointingtovarious
alternativepolicychoicesandraisingquestionsalongtheway,whicharemeant
as‘foodforthought’.
2. Descriptions in plain English, while explaining technical terms where needed.
The reason is simply to provide a guidebook for a broad audience, including
university students, journalists, finance professionals and the interested public
thatmaynothaveanacademicbackgroundineconomicsorfinance.
3. Euro areapolicies.The bookdoesnotdiscussmonetary and financialpolicyin
non-euroareacountriesinEuropeorotherpartsoftheworld.Nonetheless,italso
coverstheinternationaldimensionofthethreepolicyareasfromtheperspective
oftheeuroarea.
Thebookisstructuredasfollows:Chap.1providesthe‘layoftheland’forthe
monetaryandfinancialsystemintheeuroarea.Chapters2,4and5discussthethree
statedpolicyareas:monetarypolicy,bankingsupervisionandfinancialstability.As
the policy framework for the latter two was revamped due to the crisis, their
discussion is preceded by an overview of the main crisis episodes in the euro area
since 2007 (Chap. 3). Chapter 6 integrates the main findings and discusses the
interactionofthethreepolicyareas(seeFig.1).
This book benefited from comments and helpful thoughts by various people. In
particular,IwouldliketothankVeronikaArnold,GregorEperjesi,StefanSchmitz,
RalphSpitzer,severalanonymousreviewersinthefieldofcentralbankingandmy
brothers Albert, Konrad and Ulrich, all of whom read and commented on various
chapters.SpecialthanksgotoKevinKalaugherforhiskindpermissiontousesome
of his cartoons in the book. I am also grateful to Rocio Torregrosa, Irene Barrios-
Kezic and other colleagues at Springer International Publishing for showing confi-
dence in my work and for their patience and help. Any remaining errors and
omissions are my sole responsibility. While the book is mainly based on real-
world observations, any views expressed are solely those of the author and do not
necessarilyreflectthoseoftheEuropeanCentralBankortheEurosystem.
Most issues in the field of monetary and financial policy are interconnected.
Suitable policies therefore need to be based on a thorough understanding of the
objectives and interaction of the various policy functions. The book can hopefully
provide some clarity on this issue to readers who are new to the field. As regards
taking thenext step anddeveloping new policies, a lot ofanalysisstill needs tobe
done. There are no shortcuts in developing well-thought-out policy alternatives,
despite the tempting calls by some people that offer simple panaceas or grand
solutions. With sufficient openness, understanding and diligence, I am sure that
Preface vii
Chapter 3:
Chapter 4:
The financial
Banking
crisis in the
supervision
euro area
Chapter 2: Chapter 6: Chapter 5:
Monetary Policy Financial
policy interaction stability
Chapter 1:The monetary and financial system
Fig.1 Structureofthebook
readerswillhaveanintellectuallyfascinatingandliberatingexperiencetoinvestigate
furtherthepoliciesthatwouldbeneededtoshapethemonetaryandfinancialsystem
ofthefutureinanappropriatemanner.
FrankfurtamMain,Germany M.Fandl
August2017
Contents
1 TheMonetaryandFinancialSystem. . . . . . . . . . . . . . . . . . . . . . . . . 1
1.1 TheMonetarySystem. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
1.2 TheFinancialSystem. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
1.2.1 FinancialInstitutions. . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
1.2.2 FinancialMarkets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
1.2.3 FinancialInfrastructure. . . . . . . . . . . . . . . . . . . . . . . . . . 36
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
2 MonetaryPolicy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
2.1 PolicyObjectivesandInstitutionalSetting. . . . . . . . . . . . . . . . . . 41
2.2 PolicyInstruments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
2.3 PolicyProcess. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
2.4 InternationalDimension. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78
3 TheFinancialCrisisintheEuroArea. . . . . . . . . . . . . . . . . . . . . . . . 81
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96
4 BankingSupervision. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97
4.1 SingleSupervisoryMechanism. . . . . . . . . . . . . . . . . . . . . . . . . . 98
4.2 SupervisoryPolicy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103
4.3 InternationalDimension. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124
5 FinancialStability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125
5.1 SystemicRiskAssessment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126
5.2 MacroprudentialPolicy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135
5.3 InternationalDimension. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 146
6 PolicyInteraction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149
6.1 MainCharacteristicsoftheThreePolicyFunctions. . . . . . . . . . . . 149
6.2 PolicyInteraction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153
FurtherReading. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 163
ix
x Contents
Epilogue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165
Annex. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167
AnnexA:BasicStructureoftheEuropeanUnion. . . . . . . . . . . . . . . . . 167
AnnexB:BasicsofAccounting. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169
AnnexC:BasicsofCorporateFinance. . . . . . . . . . . . . . . . . . . . . . . . . 171
AnnexD:BasicsofCreditRisk. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173
AnnexE:SimplifiedEurosystemBalanceSheet. . . . . . . . . . . . . . . . . . 174
Index. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 177